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VMware Is Not What You Think

Software handles and service blades add up to a brilliant cash machine.

"You witch me in it;Surprise me to the very brink of tears:Lend me a fool's heart and a woman's eyes,And I'll beweep these comforts, worthy senators."-- From "Timon of Athens," by William Shakespeare, 1623

You know VMware(NYSE: VMW) as a software company, acquired and then spun out again by storage expert EMC(NYSE: EMC), firmly in the business of selling expensive software licenses. Would it surprise you to find out that license sales is actually the second largest source of VMware's sales?

VMware just reported first-quarter GAAP earnings of $0.19 per share, modestly above the year-ago period's $0.18 per share. Sales landed at $634 million, and that 35% growth was driven harder by support service contracts than by license sales.

License revenues increased 21% year over year while services gained a more impressive 51%, and the service component is now 3% larger than the software sales themselves. This is exactly how open-source software vendors like Red Hat(NYSE: RHT) make a living off of software you can get for free, and it's a new twist on the old "give away the handles and sell the razor blades" model popularized by Procter & Gamble subsidiary Gillette and robotic surgery mavenIntuitive Surgical.

The idea is simple: once your installed base of software (or surgery robots, or razor handles) reaches critical mass, the renewable sales on support services (or disposable attachments, or razor blades) accelerate past the basic sales very quickly. Assuming that VMware doesn't lose a significant chunk of its customers to rivals like Microsoft(Nasdaq: MSFT) or Citrix Systems(Nasdaq: CTXS), which is a pretty safe bet, those renewable support contracts will keep rolling in for many years even if VMware stops innovating.